Monday, November 10, 2008

Saudi Arabia: Expanding Surplus, Falling Oil Prices and Riyadh's Sway

In spite of the falling price of crude oil, the Saudis are working on an ambitious investment project to expand their surplus oil production capacity to 12.5 million barrels per day in 2009. The plan serves Riyadh’s strategic objective of upholding the kingdom’s geopolitical primacy in the global energy markets.

Analysis

The price of crude oil dipped to $57.62 Nov. 6, its lowest level since early 2007. The drop occurs amid a widespread financial crisis hitting the three main economic hubs of the world: the United States, Europe and Asia. Though to some extent the Organization of the Petroleum Exporting Countries (OPEC) appears to have cut oil production, the cut still has not been enough to buoy the price of oil and bring relief to politically strained and petrodollar-dependent Iran and Venezuela.

The Saudis, however, are still strutting with style. The Saudi government has some $400 billion in foreign assets sitting in its central bank, and with the government budget already set for $45 oil, the Saudis could come out of 2008 with a surplus of around $150 billion. Cushioned with petrodollars, the Saudis have time to plan for the future and ensure their geopolitical primacy in the oil markets.

Saudi Arabia’s massive oil reserves are both a blessing and a curse. With oil wealth, Saudi Arabia is a powerful player in the international arena, arming it with the tools to sink or support other regimes through its leverage in the energy markets. Without oil wealth, Saudi Arabia is a desert backwater.

Though oil wealth allows multibillion-dollar arms purchases, these alone cannot transform the Saudi military into a professional fighting force when the country lacks the training, experience, skill and discipline to fight even a small war. But by creating a codependency with an energy-hungry superpower like the United States, Saudi Arabia can more or less outsource its military requirements. Without oil revenues, the Saudi royal family would be unable to pacify and subsidize a deeply divided population and to combat internal and external threats to its rule. But an oil-rich economy has created a work force in Saudi Arabia that largely lacks the skills, training — and most important, the will — to develop industries independent of oil for long-term growth.

If Saudi Arabia wants to remain the leading Sunni power in the Arab world and a highly influential player in global energy politics, it must have the surplus oil production capacity to ensure its position as the swing player in the energy markets. Without such a production buffer, Riyadh would not be able to bend Washington’s ear on matters like Iran whenever Saudi Arabia sees the need. OPEC’s total surplus crude oil production for 2008 is about 1.55 million barrels per day (bpd), almost all of which is held in Saudi Arabia, at a time when global crude consumption is at around 85 million bpd. With the margin so thin, oil prices became all the more vulnerable to supply disruptions.

Now that the global economic contagion has depressed demand, there is more oil in the market to give oil prices more wiggle room. Saudi Arabia can thrive in this type of market simply by ensuring it has enough spare capacity either to flood or drain the energy market at will.

To this end, Saudi Arabian Oil Co. (Saudi Aramco) is working on an ambitious $129 billion project to raise its oil production capacity to 12.5 million bpd in 2009, construct new petrochemical plants and refineries so it can move up the value chain, and invest in advanced exploration and production technologies to increase Saudi Arabia’s proved recoverable reserves from 260 billion barrels to more than 450 billion barrels within the next two decades.

With plans to up their country’s oil production capacity to 12.5 million bpd, a 32 percent increase, the Saudi royals essentially are building an insurance plan: The more oil Saudi Arabia keeps in reserve, the more leverage it holds in the energy market.

To accomplish this, the Saudis need not trouble themselves with increasing the number of operational oil fields. Those reserves need to be safeguarded for hard times far down the road, when Saudi Arabia actually must worry about having its existing oil production sites run dry. Instead, the Saudis will work to maximize production at existing fields. Those fields include Khurais, which is expected to produce 1.2 million bpd in 2009; Shaybah, where output will rise from 500,000 bpd to 750,000 bpd in 2009; Khursaniyah, which will produce 500,000 bpd in 2009; Manifa, an offshore field that will yield 900,000 bpd in 2011; and Ghawar, the world’s largest oil field, which has been in production since 1951 and has seen a surge in drilling activity in recent years.

The Saudis cannot simply live by a “drill, baby, drill” mantra in extracting oil from these fields. Many of these fields are old and must be treated with care. As Abdullah al-Naim, vice president of petroleum engineering for Saudi Aramco said in a recent Forbes interview, “We go really slow and soft … Ghawar we treat as you would a young woman.” Saudi Aramco uses technology that restricts the penetration of the drill in creating the oil well, thereby reducing the resulting water flow that could end up damaging the field. This is a delicate and expensive process, but a necessary one if Riyadh hopes to maintain its vigor in global energy politics in the longer run.

Saudi Arabia’s investment plans should be of increasing concern to oil producing states like Iran, Venezuela and to a lesser extent Russia, which probably are all on Riyadh’s target list. Historically, the Saudis have a penchant for using their oil wealth as a weapon to drive competitors out of the energy market, thereby cutting the legs out from under geopolitical rivals.

By increasing their production capacity, the Saudis are essentially building up an arsenal to swing the energy market in their favor. For the Saudis, $30 crude is a pinch to the purse, but an eminently survivable one. For the Iranians or the Venezuelans, however, it could mean a matter of life or death for the regime. Regardless of whether Saudi Arabia follows through in massive production cuts or boosts, the mere threat of such action creates hefty geopolitical sway — something that can only be reinforced with a large enough surplus crude production capacity.